| Seth Klarman, Baupost Group (photo credit: Daniel Acker/Bloomberg) |
Like many hedge fund firms, the folks at Baupost Group are very concerned about the extremely low level of volatility in the markets.
This is a recurring theme sounded in a number of quarterly letters that are just starting to be sent by hedge fund firms to their clients. And while many equity fund managers — especially those that just go long the big-name internet stocks that are driving the indexes — are happy about the surging equity markets, Jim Mooney, who earlier this year was named president of Baupost, is not sharing their exuberance.
He devotes a significant amount of space to the potential dangers of low volatility in the firm’s seven-page July 13 letter to investors, according to an individual who has seen the document. The firm declined to comment.
In the letter, which discloses second-quarter performance, Mooney outlines the risk of sustained low volatility and the potential longer-term consequences.
“In investing, things which are unusual, unprecedented, and probably unsustainable come to feel normal with the passage of time,” Mooney warns. “Put simply, the persistence of something strange makes it feel less strange.”
Take the prospect for negative interest rates. “The persistence of the once unimaginable does not render it any more reasonable,” Mooney states.
Why does an extraordinarily low level of volatility matter? Mooney says the answer lies in volatility’s influence on risk-taking and, by extension, leverage.
“In any elevated market, one very important thing to identify is where leverage exists in the system — both that which is obvious and, more perniciously, that which is hidden,” he elaborates. “While leverage is not directly responsible for every financial disaster, it usually can be found near the scene of the crime. Structural leverage linked to low realized volatility may well prove destabilizing and the precipitant, or at least an accelerant for the next financial crisis.”
Baupost, best known for its value-driven, eclectic investment style, tells clients it made money in the first quarter and first half of the year, although it does not provide a specific performance figure. According to a person familiar with the firm’s performance, Baupost was up in the low single digits through June. Last year Baupost’s main fund was up 9 percent. Baupost also said it was a net seller for the period.
Seth Klarman, who is chief executive officer and principal owner of Baupost, did not sign the letter. However, this is not any indication of a change in his status or role at the firm. Since 2013, Mooney or another individual has signed at least one quarterly letter instead of Klarman, and Mooney is expected to continue to do so in the future. He remains head of the public investment group and a member of the management committee.
Elsewhere in the letter, Mooney also addresses the risks of what he calls the “least predictable president in recent history (if not ever),” whose administration, he asserts, “is plagued by scandal.”
He adds that despite one-party rule in Washington, Congress has devolved into what he describes as intra-caucus gridlock, “causing passage of the very policies that infused such optimism in the markets to become increasingly uncertain.”
Well, that could lead to more volatility.
